Some of the 482 funds in the Forbes Closed-End Fund Ratings are great buys. Most are dreadful places to put money. This article explains how to distinguish the good from the bad.
We scored closed-end funds on two metrics: past performance and cost. The performance grade is based on a simple comparison of ten-year results (for the funds that have been around that long) to those of similar funds. Just as important as past results—more important, if you subscribe to the philosophy of John Bogle—is the cost of a fund. That’s a trickier matter.
The expense ratio of a closed-end fund is just the starting point in a cost assessment. Also in play is the interaction between the distribution rate on a fund and the discount (or premium) at which the fund trades. Our ratings do the arithmetic for you. Below, we’ll take a look at what’s going inside our cost calculator.
The closed-end format, which commands $220 billion of customer money, is a somewhat unusual beast in the wilds of Wall Street. Although this species of investment company is the most ancient, it has been eclipsed in market share by the open-end (or mutual) fund and, more recently, the exchange-traded fund. Mutual funds and ETFs allow capital to flow in and out. Closed-ends don’t. Their capital is frozen in place.
After the organizer of a closed-end fund has raised capital by selling stock, investors can get in only by persuading existing shareholders to part with some shares. They can get out only by finding new investors to take shares off their hands.
Thus, supply and demand determine the price at which a share of a closed-end changes hands, and that price can be higher or lower than the value of the assets attached. Central Securities Corp. (CET) was trading on Mar. 31, 2019, at 83 cents on the asset dollar. Gabelli Utility Trust (GUT) exhibits the reverse phenomenon. To get a dollar of its assets you had to fork over $1.39.
That discount (or premium) is one of the elements of a cost analysis. A discount interacts with a cash payout from the fund to deliver an instant profit into your hands.
Consider Central Securities, where you get $100 of portfolio assets for $83. This fund pays out 3% of its portfolio annually. Your $3 of dividends represents cash you acquired at a 17% discount, which is to say, at a cost of $2.49. So you’re getting a 51-cent annual bonanza on top of whatever the portfolio return is.
One way to view the bonanza is as a negative cost, equal to 0.51% of your $100 piece of the portfolio. (The -0.51% figure is the product of -17% and 3%.) This cost offset is large enough to cover most of the 0.68% expense ratio on the fund.
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How To Find Bargains In Closed-End Funds